“… Higher water rates, little recourse for consumers”

December 18, 2011

PFLUGERVILLE — When Robert White opened his water bill last month, his jaw dropped: $250 for a month’s worth of water and sewer service. The 63-year-old construction contractor, who shares a three-bedroom home with his wife in the bucolic Springbrook Centre subdivision, said he likes to keep his lawn green and expects hefty water bills. “I just don’t want to be hijacked,” he said.

White’s water service is provided by a private utility owned by California-based SouthWest Water Co. LLC. Just across the four-lane Pflugerville Parkway, where White’s neighbors in the Springbrook Glen subdivision — a nearly identical grid of neatly arranged brick-faced homes — get their water from Pflugerville, rates are on average about 60 percent less.

And White’s bill for water service may nearly double soon, if SouthWest Water gets the latest rate increase it has requested. “I have never felt so helpless,” he said.

He’s not alone. Across the state, a growing number of suburban Texans are getting their water from large, private corporations owned by investors seeking to profit off the sale of an essential resource. State figures show private companies are seeking more price increases every year, and many are substantial.

The Texas Commission on Environmental Quality, which regulates water and sewer rates for nonmunicipal customers, doesn’t keep numbers, but “their rate increases tend to be 40 and 60 percent,” said Doug Holcomb, who oversees the agency’s water utilities division.

For years, small private companies have played a crucial role in Texas, providing water and sewer service in new developments outside of cities. Analysts say private companies will continue to fill an essential need in the future, when public money is projected to be insufficient to make the billions of dollars in costly upgrades needed in water and sewer systems.

Increasingly, however, the companies are neither small nor local. Over the past decade, multistate water utilities have expanded aggressively in Texas, drawn by the state’s booming population and welcoming regulatory environment. A September report prepared by utility analysts for Robert W. Baird & Co., a financial management company, identified Texas water regulators as the most generous in the country for private water companies. Today, three out-of-state corporations own about 500 Texas water systems that serve more than 250,000 residents.

For residents living outside cities served by private utility companies, the state environmental commission is charged with setting “just and reasonable” water rates based on a company’s cost of doing business plus a guaranteed profit. In exchange, the companies enjoy a monopoly on their service area.

Yet critics say the agency is unprepared to handle the recent influx of corporations that have exploited a regulatory system more accustomed to handling rural mom-and-pop operations. Meanwhile, Texas laws provide fewer consumer protections to residents facing water rate increases than electricity and gas ratepayers.

“We are in the midst of a transformation in this state, and the state is ill-prepared to move into that transition,” said Sen. Kirk Watson, D-Austin, who co-chairs a legislative subcommittee to investigate the rates charged by investor-owned water utilities. “It feels like it’s happening at warp speed.”

Industry officials say their rates reflect the true cost of rehabilitating and expanding older water systems, and that without their deep pockets, such systems would languish. The “larger Investor-Owned Utilities have invested in small, rural water and sewer systems that have gone decades without meaningful improvements in their infrastructure and often do not meet minimum environmental standards set by the state,” SouthWest Water spokeswoman Janice Hayes said in an email, adding that the companies have poured millions of dollars into new equipment and upgrades.

But in some places, the rate increase s following those improvements have been so high as to inhibit economic growth. Just south of Austin, SouthWest Water seven years ago purchased rights to provide water on the eastern edge of Kyle. Today, officials say, its rates are about double those of the city.

As a result, the company’s service area is one of the few desirable commercial locations — just off Interstate 35 — where fast-growing Kyle has remained underdeveloped, said Diana Blank, the city’s director of economic development. “We’ve lost projects because of that,” she said. Prospective employers “will look at the map and say, ‘Who serves the area for water?'”

SouthWest’s latest rate request, which would increase rates for some suburbanites to more than three times what Austin residents pay, has caught the attention of lawmakers. A half-dozen legislators said they will introduce changes to the law during the next session to provide more consumer protections.

“This may be the poster child for the kinds of reforms we need,” Watson said. “Some utilities will stretch the law as far as they can stretch it.”

‘Shock and awe’

In Texas, state agencies oversee consumer rates charged by utility companies, which must persuade regulators that rate increases are necessary. But nonmunicipal private water companies enjoy an advantage over electric and natural gas companies: They can raise rates before they’ve been approved.

At the Public Utility Commission, which oversees electric companies, and the Texas Railroad Commission, which regulates gas companies outside cities, agency accountants typically review applications and negotiate with the utilities over the proposed rates. Only after that process, which can take months or longer, do the charges go into effect. Other states do the same, with proposed rates negotiated before customers ever receive a higher bill.

By comparison, the Texas “file and use” system generally permits private water companies to impose new, higher rates as soon as they’re filed. Protests are addressed later and can go on for years.

“It doesn’t really matter how long the rate case takes if you’re already earning what you think you’re going to get,” Heike Doerr, a national utility analyst, said in a recent speech in which he identified Texas as friendly to water companies.

“The people who want to oppose it are always on the defensive,” added Tom “Smitty” Smith, director of the Texas office of Public Citizen, a nonprofit consumer and environmental advocacy organization.

If fewer than 10 percent of a utility’s customers complain, the new rate typically becomes permanent. If customers do mount a campaign against the rate, they’re on their own.

That highlights another difference in the way in which water companies outside cities are regulated. When electric companies petition the Public Utility Commission for rate increases, ratepayers are represented by a separate taxpayer-funded office, the Public Utility Counsel, whose accountants and attorneys review the request and advocate for consumers. It can also hire consultants on their behalf.

Other states have a similar system for water customers. Arizona set up the taxpayer-funded Residential Utilities Consumer Office nearly 30 years ago to represent ratepayers in contested cases.

In Texas, however, private water customers who live outside cities must foot their own bill to fight rate increase s. Although the state environmental quality commission has an office called the Public Interest Counsel, it is prohibited from offering legal advice to customers, much less representing them.

One Henderson County community has hosted bake sales and chili suppers to raise money to fight SouthWest’s proposed 50 percent water rate increase s. In Comal County, customers have been asked to donate money to protest SJW Corp.’s proposed 71 percent rate increase — its third in three years, said community leader Geoff Miller.

“If you don’t have qualified professionals equal to those hired by the water company,” he said, “then your chances of being successful are very small.”

Texas law also entitles private water companies to recover the cost of the rate-making process through customer billings. In 2004, a multistate investor-owned water company called Aqua America requested a rate increase for several Texas developments and cities. It wrapped up in 2007 after more than three years of wrangling. Aqua’s legal and consulting costs were more than $2.5 million, a figure the company tacked onto customer bills.

Even if they win, Texas ratepayers have no such recourse. Requiring residents to take on big companies on their own dime while paying the new higher rates pressures them to settle disputes as quickly as possible, critics say.

At the same time, they say it encourages private companies to use a strategy Watson termed “shock and awe” during a contentious Senate hearing on the subject over the summer: Hit customers with a large rate increase , then drag out the case.

“I believe your company does engage in that,” Watson told SouthWest’s vice president. “And I believe you and your company tend to be rather smug about that.”

Agency overwhelmed

In 1986, when water rate-making authority was moved from the Public Utility Commission to the Texas Water Commission, now part of the Texas Commission on Environmental Quality, the arrangement seemed to make sense: The private water landscape was overwhelmingly populated by small, local companies with few customers each. The agency’s role, said Joe Freeland, an Austin attorney who represents water customers, was often more to assist the often-struggling companies than to police them aggressively.

But with more small companies being snapped up by large corporations, he and others say the environmental agency can be overwhelmed by corporate attorneys and accountants representing their clients. In 2007, an agency analyst evaluating an Aqua rate case testified it was “25 times larger” than any case he’d tackled previously.

Critics point to examples in which, given the same case, city and state regulators obtained much different results for consumers.

When private utility companies want to raise rates on customers in their service territory who also live within a city’s limits, city officials — not the state’s — consider the case. In 2002, a private company called Tall Timbers, which had customers in and outside the city of Tyler, filed to increase its sewer rates. The Texas Commission on Environmental Quality signed off on the increase for the company’s out-of-city ratepayers.

The City of Tyler, meanwhile, “conducted a more thorough review,” recalled utilities and public works manager Greg Morgan, and concluded the rates should actually be lowered by $10 a month.

Tall Timbers objected, and the case went next to a state administrative law judge — who calculated the “just and reasonable” rate for the utility’s Tyler customers was even lower than the city had found.

Since then, the environmental commission has signed off on another rate increase for the utility’s customers outside the city. Today, Morgan said, those customers pay twice as much as their neighbors in Tyler, “so we’ve ended up with two classes of citizens.”

In recent years, private water companies have asked for rate increases more frequently. In 2006, the environmental agency received 70 requests. Last year, it was 129 — an 84 percent jump. At the same time, the agency’s water rate review division has seen its budget shrink over the past three years.

Earlier this year, the Sunset Advisory Commission, which reviews state agencies, recommended legislators move water rate regulation from the environmental quality commission to the Public Utility Commission, which has a larger staff experienced in fielding complex rate cases.

Representatives of the large water companies protested, contending the environmental agency was doing an adequate job. Legislators did not act on the advisory commission’s recommendations, leaving rate reviews with the agency.

“TCEQ is not as sophisticated as some public utility commissions” in other states, SJW Corp. CEO W. Richard Roth told analysts in a December presentation. “That can be good, and that can be bad.”

Numbers questioned

In Central Texas, no private water company has caused more of an uproar than SouthWest Water, which in 2000 purchased two water companies in Pflugerville and eastern Travis County, where population was projected to grow rapidly.

Over the next decade, SouthWest aggressively acquired other small companies, seeking to cluster them into regional water providers. State regulators and lawmakers have promoted such regionalization to encourage economies of scale within the state’s patchwork of nearly 700 private water and sewer service areas.

In 2004, SouthWest made a key acquisition: Tecon Water Co., which served 21,000 water connections, including many along the eastern edges of Kyle and Buda. The $66 million purchase represented more than just a bet on a high-growth area; it also came with a special legislative exemption that Tecon had been granted a year earlier.

State law requires water companies to have separate rate schedules for each of their water utilities — unless they can prove the utilities are “substantially similar” (the idea being that ratepayers in one area shouldn’t subsidize those in another). The Tecon clause allowed the company to bypass state law and consolidate various water companies under one entity with a single tariff. Seven years later, the exemption would become the basis for SouthWest Water’s current rate increase proposal, affecting 46,000 water and sewer customers.

In 2010, private investors advised by J.P. Morgan bought publicly traded SouthWest for $430 million, a high price, according to some experts. “Observers are still scratching their heads trying to figure out how the investors will actually earn a return on the premium valuation that they paid for the company,” Debra Coy, a leading water utility analyst, wrote in the trade magazine American Water Intelligence.

A year later, SouthWest Water began the process of raising rates so much they became the focal point of hearings at the Texas Senate.

Using the Tecon exemption, SouthWest Water first applied for permission to merge eight of its Texas water utilities under the Monarch Utilities banner, then asked for a single rate that would produce bills nearly three times the size of the average water bill for municipal customers in Texas.

SouthWest officials say the rate request isn’t linked to the 2010 purchase that took the company private but is instead needed to pay for a $70 million upgrade to old water systems — much of which was mandated by state regulations. To encourage such upgrades, state regulators give private companies rates of return of up to 12 percent on the equity they invest.

Yet critics have questioned other numbers in Monarch’s 1,700-page application for a higher rate, especially nearly $10 million in corporate management and utility group fees. “Our suspicion is that there must be some kind of corporate overhead price that others don’t charge because they don’t have a parent company owned by J.P. Morgan,” said Simon Sequeira, president of Quadvest, a small investor-owned water company northwest of Houston. Sequeira and other small-utility owners have formed an association seeking to distance itself from what it calls the unreasonable rates sought by the larger newcomers.

TCEQ officials also have questioned $4.3 million in “public company costs” given that SouthWest is no longer publicly traded, and another $1.2 million for computer and IT services in California, where SouthWest is based. SouthWest officials said management fees go toward legal, financial, engineering and customer service-related work.

SouthWest Water ratepayers, including residents from Bulverde, near San Antonio, and Blue Mound, outside Fort Worth, have organized to protest the rates. Because they would also affect residents within cities, several municipalities, including Pflugerville and Kyle, have hired an attorney to fight the case.

Customers said they fear the proposed increase would deplete family budgets, make homes harder to sell and inhibit commercial development in their neighborhoods. Austin’s Colony, a neighborhood of moderately priced homes in eastern Travis County served by Hornsby Bend — a small company that SouthWest bought in 2000 — has experienced one of Travis County’s highest foreclosure rates. When the proposed rates temporarily went into effect over the summer, residents saw their water bills jump by about half.

Lucio Camarillo, a construction worker who lives in the neighborhood with his daughter, said he began paying water and sewer bills of about $150, in addition to the $130 a month he spends to pay for a water softener system, which he says was necessary because of the quality of the water. He said he had to cut his cable service and carefully ration water.

“If I had known it was going to be like this, I probably would have bought in the city,” Camarillo said.

SouthWest Water also provides wholesale water to Kennedy Ridge, a nearby low-income subdivision where rates sparked an investigation by the state attorney general’s office. After the company was charged with violating the Deceptive Trade Practices Consumer Protection Act, SouthWest this year agreed to credit Kennedy Ridge nearly $77,000 in restitution and to follow certain rules on increasing rates.

Last month, State Office of Administrative Hearings judges took the unusual step of setting an interim rate that rolled back rates in all eight SouthWest Water subsidiaries to their previous levels until the case is decided. They will next rule on whether SouthWest Water can merge and, if that effort is successful, will then take up the rate case again. A final decision is likely months or even years away.